Arbitrary Nature of Financial Stability Oversight Council and the "Bail Out Nation "

March 6,2017
the staff of the Ridgewood blog

WASHINGTON DC, The House Financial Services Committee released a staff report which reveals that the Financial Stability Oversight Council (FSOC) acts inconsistently and arbitrarily in exercising its power to designate certain non-bank companies as “too big to fail.”

Based on documents requested by the Committee nearly two years ago and the sworn testimony of Treasury Department officials, both of which were only obtained as the result of a Congressional subpoena, the report shows that not only is FSOC’s analysis inconsistent, FSOC does not even follow its own rules—to the extent that FSOC even has rules that could be consistently followed.

“Today’s FSOC designations are tomorrow’s taxpayer-funded bailouts. The FSOC typifies Washington’s shadow regulatory system of powerful government bureaucrats, secretive meetings, arbitrary rules and unchecked power to punish enemies and reward friends,” said House Financial Services Committee Chairman Jeb Hensarling (R-TX). “The Obama Treasury Department tried to keep Congress and the American people in the dark about how FSOC exercises its sweeping powers. The release of this staff report brings some much-needed transparency and oversight to FSOC, and the information contained in the documents clearly demonstrates the need for the accountability reforms Republican have proposed in the Financial CHOICE Act.”

The staff report – which details the non-public analysis associated with FSOC’s processes to designate certain firms as so-called “systemically important financial institutions” and therefore “too big to fail” – comes in the midst of the FSOC’s appeal after a federal district court overturned FSOC’s designation of MetLife and characterized the designation as “arbitrary and capricious.”

In response to previous concerns that its designation process is arbitrary, FSOC has repeatedly stated that its analysis is based on “industry-specific and company-specific factors” without making clear what that meant in practice. But these documents bring to light that FSOC took into account certain factors when designating one company while refusing to consider those identical factors in the designation of another company.

One instance where FSOC did not treat two companies the same was its evaluation of a company’s vulnerability to material financial distress.

For the four nonbank financial companies that the FSOC designated as systemically important financial institutions (SIFIs), the FSOC did not evaluate the vulnerability to material financial distress of those companies. The FSOC has claimed in court both that it is not required to evaluate the probability or likelihood of material financial distress at a nonbank financial company, and that the FSOC’s own guidance does not state it will do so.

The Committee-obtained FSOC documents reveal that the FSOC evaluated the vulnerability of some companies to material financial distress – and then declined to designate those companies. The FSOC made multiple statements about the vulnerability to financial distress of some companies in their confidential evaluations such as “temporary market disruptions would be unlikely to threaten the imminent solvency” of a company, or for another company that its available liquidity resources “make it less likely for liquidity concerns and maturity mismatches to translate into a viable source of systemic risk.”

The FSOC’s documents neither explained this disparate treatment, nor was it explained to the court. This and other instances of disparate treatment of similar factors at different companies calls into question the entirety of FSOC’s analysis and its reliance on “company-specific” qualitative factors as justification for its designations.

These documents also show that the FSOC does not follow its own rules for the nonbank designation process. The FSOC says that it will “assess the impact of the nonbank financial company’s material financial distress in the context of a period of overall stress in the financial services industry and in a weak macroeconomic environment.”

But the documents that are discussed in the staff report detail a number of companies where the conclusions reached by the FSOC were made based on a scenario of the company failing “in isolation,” as opposed to reaching its conclusions in a scenario where there are “developments that cause distress at [the company] and other firms simultaneously.”. These companies were not designated by the FSOC. The reason the FSOC did not follow its own rule was not explained in the documents or the testimony of Treasury officials.

The Financial CHOICE Act – the Republican plan to replace Dodd-Frank and promote economic growth – includes provisions that eliminate FSOC’s authority to designate certain firms as “too big to fail” and rescinds previous FSOC designations. In addition, the CHOICE Act would require the FSOC to operate with a higher degree of transparency and inclusiveness.